The question “What is Unrelated Business income “ is confusing to a lot of churches.
According the IRS URBI is defined as an activity is an unrelated business (and subject to unrelated business income tax) if it meets three requirements:
- It is a trade or business,
- It is regularly carried on, and
- It is not substantially related to furthering the exempt purpose of the organization.
There are, however, a number of modifications, exclusions, and exceptions to the general definition of unrelated business income.
- Publication 598, Tax on Unrelated Business Income of Exempt Organizations
- Exempt Organizations Continuing Professional Education Text article (1999)
How does this affect churches? In order to find this out keep in mind the following
- Was the income derived from a trade or business? “Trade or business” is broadly defined as “any activity that generates income from the sale of goods or providing of services.” Nearly any income a ministry might collect (other than true donations) could qualify as “trade or business” income.
- Is the organization regularly engaged in the trade or business? A court would compare a ministry’s involvement to the amount of time commercial businesses spend in the same type of activity. For example, a church that leases spaces in its parking lot—even one day per week all year long—is considered to “regularly engage in” the trade or business of commercial parking. Weekly coffeehouses also might meet this requirement.
- Is the activity unrelated to the organization’s exempt purpose? This is the BIG ONE To be tax-free, an activity must be “substantially related” to the church’s exempt purpose. This question has been heavily litigated and can be the most difficult to answer. Just because money earned from business activities supports an exempt purpose doesn’t make the activities tax-exempt. A ministry must demonstrate that the activities further a purpose for which the organization is exempt, such as evangelism. While a ministry might see a coffee shop or fitness center as promoting fellowship or outreach, the IRS may see those activities as unrelated business operations. This would probably be even more likely if the church displays huge signs throughout town to promote its bookstore or coffee shop.
There are two potential exceptions to the applicability of UBIT.
1: If “substantially all” of the labor involved in the trade or business was provided by volunteers.
2: If “substantially all” of the merchandise being sold has been donated to the organization. This exception would likely apply to bake sales, craft markets, thrift stores, etc. Please keep in mind for this one, if you buy items, and pay people to sell them, than this income is considered taxable.
One other situation that I have personally experienced with a church client was they wanted to rent a piece of land to a Christian school , which is a good idea, and supports another ministry, there was a mortgage on the property any rent paid would have been considered taxable.
Is There a Limit to How Much Can We Earn?
Many ministries are unsure of whether their income is taxable or not and take the stance, of if we don’t know, then we are better to stay away from it, others know it could be taxable but need the income and thus do not report it. Ministries should be cautious about adopting the second viewpoint; however, because earning too much unrelated business income could cost the ministry its tax-exempt status.
Here’s a general rule of thumb to follow: If more that 15 percent of your ministry’s total earnings come from unrelated business income, your ministry should consider the risk of losing its tax-exempt status and discuss this concern with a tax professional.
Please feel free to contact our office for more guidance